Monthly Mission: Measure Your Balance Sheet To Improve Your Surety Relationship

It’s that time of year!  Larger jobs are on the horizon and the goal is building backlog.  Many of these jobs require bonding and many contractors are surprised to learn they can’t bond “the job” that fits perfectly in their schedule.  The reason, they discover, is that their Balance Sheet isn’t strong enough for the surety to support the size of job or the additional work being requested.

Sometimes the situation happens overnight when a job takes a turn for the worst.  Other times it’s a slow process where losses have accumulated or debt has slowly increased to the point that the ratios are not healthy.  We’ve also seen where it was just a misunderstanding based on how the financial information was presented!  This seems to create a circular situation:  You need the job to improve your financial position so that you can get bonding, but you can’t get the bonding to get the job.

Whatever the reason or the concern, we want to make sure you know how your Balance Sheet affects your bonding capacity so you don’t get an unpleasant surprise.  That seems like a great Mission this time of year.

Here are 5 areas to assess so you know your financial health, your bonding program and your surety relationship are strong and stable:

1. Make sure you have accurate financial information – If you are not producing financial statements on a percent-complete basis, it is difficult for the surety to provide bonding. Without this method of accounting, they have difficulty determining how your jobs, and your company, are performing.  This step also tends to be the first step in fixing #3-5. Accurate financial statements are required to assess whether you have the financial requirements met.  Since financial information is the language your surety uses to understand your business why not give them the clearest information possible.
2. Strengthen the relationship with your surety – This isn’t a measure but a key step nonetheless.  Some contractors don’t know their surety or what their surety expects from them financially. They have a relationship with their insurance agent and assume that is enough.  The surety is not your insurance agent, but the person in charge of your bonding at the surety company.  Your surety is your representative who goes to bat for you, using your financial data, with their credit department to make sure you can get the bonding you need, when you need it.  Understanding how the surety views your information is critical.
   1. Ask your insurance agent to schedule a meeting for you and your surety to get to know each other and review your data together. Everyone will be happy you asked for this meeting.  This is a great investment of time.
   2. Have an agenda or key questions you would like answers to. Our favorites are:
   3. How do they calculate your bonding capacity, using your data? (We have an example in our All Access site if you’d like to watch it before your meeting.)
   4. How often would they like to hear from you? (Annually, quarterly, etc.)
   5. What financial data would they like to see and would they walk through your financials with you?  You can learn a ton by having them walk you through what they see.
   6. Share your goals for the business. Sharing your goals for the future of your business helps your surety know where you are headed and how they can help.
3. Assess your Equity – Equity is a requirement for a solid bonding program. If you don’t have equity you typically don’t have a bonding program.  Know how much your surety requires.  If you find that your equity position is low, it may be time to invest cash back in your business.  This can be easier said than done but there are ways to strengthen your equity.
   1. Some owners have savings outside of the business or are comfortable with outside capital. If this is for you then you may consider an additional investment in the business.
   2. Many people use their bank for times like these and leverage specific assets owned outside of the business. The capital from leveraging these assets gets put in the business to strengthen equity.
   3. Financial projections for the Balance Sheet can also help by planning distributions and postponing large payments until you know you have the equity your surety requires.
4. Check your Working Capital – Working Capital can be depleted in multiple ways, but the most common is too much debt or past net losses (as opposed to net income). It can also be improper accounting practices, such as misclassified current assets or current liabilities.  Know how much Working Capital your surety expects to see.
   1. Understanding the cause will help you understand how to fix it. Developing and using a budget to make sure your spending is on track is one way to fix or prevent a shortfall in working capital.  Just remember it isn’t a quick because first the business has to earn the profits to increase the working capital.
   2. Regularly scheduled WIP reviews with your PMs are another way to manage the working capital by managing profit. Knowing job profitability and staying ahead of any issues can help minimize losses or maximize profit.
   3. Understand the types of assets and liabilities on the Balance Sheet and whether they are truly current or should be classified elsewhere. You can help identify increases in working capital you may be missing out on because of a misunderstanding in classification.
   4. Refinancing short term debt to a longer amortization is an effective way to shore up working capital.
5. Debt/Equity – Sometimes companies require assets to grow. These assets can come at the cost of adding debt.  If your debt to equity is over 3.0, this can cause trouble in your bonding capacity.
   1. Look around and see if you have excess encumbered assets. Selling excess assets is the quickest way to fix this ratio.
   2. Boosting your equity is another way using the tips mentioned above.

When looking to increase your bonding capacity, also look to your outside partners and resources.  Strong construction accountants, insurance agents and sureties will help you identify ways to improve your financial condition so that bonding is more easily attainable.

You can do this!  Spend some time with your financial data and your business tends to improve.  Spend some time cultivating your surety relationships and your bonding improves.

Would you like to learn more about increasing your bonding capacity? Then check out our Build Your Own CFO training, which has everything you (or someone in your company) will need to become a construction CFO. Click here to learn more.